Economies of scaleEconomies of scale

Average total costs changes as Average total costs changes as the output of a firm changesthe output of a firm changes

Increasing, decreasing or Increasing, decreasing or constant economies of scale.constant economies of scale.

Short run cost curve (SRATC)Short run cost curve (SRATC) Long run cost curve (LRATC)Long run cost curve (LRATC)

Constant economies of scaleConstant economies of scale

LRATC

SRATC1 SRATC2

Q

Cost

Q1Q2

Increasing economies of scaleIncreasing economies of scale

SRATC1

SRATC2

Q

Cost

LRATC

Q2Q1

Decreasing economies of scaleDecreasing economies of scale

SRATC1

SRATC2

Q

Cost

LRATC

Q1 Q2

US Pork Sector Study US Pork Sector Study Financial results for 2000Financial results for 2000

Net ProfitNet Profit BreakevenBreakeven Net LossNet Loss

1-21-2 65%65% 24%24% 11%11%2-32-3 77%77% 15%15% 8%8%3-53-5 79%79% 16%16% 5%5%5-105-10 78%78% 13%13% 9%9%10-5010-50 77%77% 12%12% 11%11%50-50050-500 90%90% 5%5% 5%5%500+500+ 95%95% 5%5% 0%0%

US Pork Sector StudyUS Pork Sector StudyStay in price until 2003 (%)Stay in price until 2003 (%)

1000 hd1000 hd $36$36 $39$39 $42$42 $45$45 $48$481-21-2 1616 3636 6969 8686 90902-32-3 1818 4242 7171 8787 97973-53-5 1818 3939 7070 9090 94945-105-10 1616 3939 7575 9292 989810-5010-50 2222 4949 7474 9191 969650-50050-500 44 6161 8888 9797 9999500+500+ 2828 5050 8989 9494 100100

Processing cost curvesProcessing cost curves

Specialized plantsSpecialized plants

High fixed costHigh fixed cost

SRATC

Q

Cost

So what???So what???

Short run price implicationsShort run price implications Supply chain managementSupply chain management Open market or contractOpen market or contract

• Packing plantsPacking plants• Ethanol plantsEthanol plants• Soybean processingSoybean processing• BiodieselBiodiesel

Weekly Prices and Slaughter, 1998-99

1.2

1.4

1.6

1.8

2.0

2.2

1 14 27 40 53 66 79 92 105

$10

$15

$20

$25

$30

$35

$40

$45Price

Slaughter

Million

Externalities and cost curvesExternalities and cost curves

Q

CostCost curve exhibiting increasing economies of scale

Externalities and cost curvesExternalities and cost curves

Cost curve with external cost internalized to the firm

Cost

Q

Supply and Demand summarySupply and Demand summary

Demand originates with Demand originates with individual consumer’s utility and individual consumer’s utility and budget constraintbudget constraint

Supply originates with individual Supply originates with individual firm’s marginal cost curvefirm’s marginal cost curve

Consumption is not demandConsumption is not demand

Consumption =Consumption =• Beginning stocks + production + Beginning stocks + production +

importsimports• – – exports – ending stocksexports – ending stocks• Government reports of inventoryGovernment reports of inventory

Per capita consumption =Per capita consumption =• consumption / populationconsumption / population

Percapita Boneless Meat Consumption

0

10

20

30

40

50

60

70

80

90

100

1970 1975 1980 1985 1990 1995 2000

Beef Pork Poultry

Equilibrium P and QEquilibrium P and Q

Q

P S

D

Qe

Pe

Equilibrium price is where Qs = Qd.

Supply and Demand AnalysisSupply and Demand Analysis

Pe

Qe

Price elasticityPrice elasticity

A measure of responsiveness of A measure of responsiveness of the quantity supplied or the quantity supplied or demanded to changes in prices.demanded to changes in prices.

Percentage change in quantity Percentage change in quantity for a 1% change in price.for a 1% change in price.

Elasticity of demandElasticity of demand

Q / Q Q / Q

P / PP / PEp =Ep =

Ep =Ep = QQ

PPPPQQ

x

Ep =Ep = QQ0 0 - Q- Q1 1 P P0 0 + P+ P11

QQ0 0 + Q+ Q1 1 P P0 0 - P- P11

x

Price elasticity and curvesPrice elasticity and curves

Ep changes along a sloping Ep changes along a sloping demand or supply curvedemand or supply curve

Special exceptionsSpecial exceptions

Relative measuresRelative measures

|Ep| > 1 elastic|Ep| > 1 elastic |Ep| = 1 unitary elastic|Ep| = 1 unitary elastic |Ep| < 1 inelastic|Ep| < 1 inelastic

Price elasticity & total revenuePrice elasticity & total revenue

TR = P x QTR = P x QElastic demandElastic demand

• P and TR inversely relatedP and TR inversely related

Inelastic demandInelastic demand• P and TR directly relatedP and TR directly related

Price elasticity & total revenuePrice elasticity & total revenue

PP

QQ

Elastic

Inelastic

So what????So what????

PP

QQ6 10

20

6055

7 11

15

Where are you on the demand curve?

Income elasticityIncome elasticity

Percentage change in quantity Percentage change in quantity for a 1% change in incomefor a 1% change in income

Positive for most food itemsPositive for most food itemsRelatively small i.e., 0.2Relatively small i.e., 0.2

Ei =Ei = QQ

IIIIQQ

x

Cross-price elasticityCross-price elasticity

Percentage change in quantity for a 1% Percentage change in quantity for a 1% change in price of a substitute or change in price of a substitute or complementcomplement

Positive or negativePositive or negative Much smaller than EpMuch smaller than Ep

EpEpjj = =QQkk

PPjj

PPjj QQkk

x

Examples of Ag elasticitiesExamples of Ag elasticities

EpEp EiEiBeefBeef -.62-.62 .45.45PorkPork -.73-.73 .44.44ChickenChicken -.53-.53 .36.36MilkMilk -.26-.26 -.22-.22GrapesGrapes -1.38-1.38 .44.44LettuceLettuce -.14-.14 .23.23

Own and Cross Price ElasticitiesOwn and Cross Price Elasticities

Ep of demand for beefEp of demand for beefBeefBeef -.62-.62PorkPork .11 .11LambLamb .01 .01ChickenChicken .06 .06OtherOther -.01-.01IncomeIncome .45 .45

Net change in quantityNet change in quantity

Net effect of changes in own Net effect of changes in own price, cross price, and income price, cross price, and income multiplied by the appropriate multiplied by the appropriate elasticities.elasticities.

Addresses the fact that Addresses the fact that not all not all else is equal. else is equal.

Elasticities at various marketsElasticities at various markets

The greater the number of The greater the number of substitutes the more elastic the substitutes the more elastic the demand.demand.

For a given Q, look at % PFor a given Q, look at % PMore elastic at retail levelMore elastic at retail level

Elasticities at market levelsElasticities at market levels

P

Q

All food All meat All beef

All T-bone

Hy-Vee T-bone

Hy-Vee T-bone in Ames

Derived DemandDerived Demand

The demand for inputs that are The demand for inputs that are used to produce the final used to produce the final products.products.

Examples:Examples:• Flour => wheatFlour => wheat• Soybean meal => soybeansSoybean meal => soybeans• Fed cattle => feeder cattleFed cattle => feeder cattle

Derived DemandDerived Demand

P

Q

Retail pork chop demand

Wholesale pork demand

Farm level demand for hogs

Demand for corn to feed hogs

Demand for inputs to produce corn

Elasticities at retail and farmElasticities at retail and farm

S

DRetail = Primary

P

Q

PR

Qe

DFarm = Derived

PF

M

Dd = f (Dd, M)

Elasticity SummaryElasticity Summary

Relationship between Q and PRelationship between Q and PChanges along demand curveChanges along demand curveElasticity and total revenueElasticity and total revenueCross-price and income elasticitiesCross-price and income elasticitiesRelative sizeRelative size

• Own, cross, and incomeOwn, cross, and income• Farm v. retailFarm v. retail